As of December 31, 2021, newly originated products for unsecured short-term lending in the interbank market will no longer be tied to the London Inter-Bank Offered Rate (“LIBOR”), signalling the beginning of its full decommission.
The shift away from LIBOR toward new benchmarks is intended to provide a truer reflection of the cost of capital, but is not a simple process. Taking its place, SOFR (the U.S. Secured Overnight Financing Rate) and other local-currency-denominated benchmarks such as the Sterling Overnight Index Average (SONIA) in the UK, the Euro-Short Term Rate (ESTR) in Europe, and the Tokyo Overnight Average Rate (TONA) in Japan, will co-exist, monitored by trade groups formed by market participants such as the Alternative Reference Rates Committee (ARRC) in the U.S.
December 31, 2021 marked the end of 24 LIBOR settings administered by the ICE Benchmark Administration (“IBA”). These 24 settings include:
- EUR overnight, 1-week, 1-month, 2-months, 3-months, 6-months, and 12-months
- CHF overnight, 1-week, 1-month, 2-months, 3-months, 6-months, and 12-months
- GBP overnight, 1-week, 2-months, and 12-months
- JPY overnight, 1-week, 2-months, and 12-months
- USD 1-week, and 2-months
GPB and JPY 1-month, 3-months, and 6-months settings are set to be published for the duration of 2022, but these rates are published under a synthetic methodology and considered unrepresentative of the underlying market. The Financial Conduct Authority (“FCA”) has published a notice outlining the applicable use cases for these synthetic rates.
The remaining USD LIBOR settings (overnight, 1-month, 3-months, 6-months, and 12-months) will continue representative publication until June 30, 2022. New usage of USD LIBOR is only permitted for limited scenarios as outlined in an additional notice from the FCA.
As previously shared, the Citco group of companies (“Citco”) was fully prepared for the December 31, 2021 cessation deadline, and the operational enhancements we have deployed have ensured our current and future reporting was able to continue unaffected.
Preparation for LIBOR cessation extends to our loan servicing vendor, Sentry, which has been fully engaged in the LIBOR transition from the beginning of the project. Sentry has adopted all calculation methodologies for alternative reference rates.
As a reminder, if you have not yet formulated a plan or approach to the transition for your USD LIBOR positions, we would recommend taking immediate action to evaluate your exposure and next steps.
Ahead of the end of year deadline when newly originated products for unsecured short-term lending in the interbank market will no longer be tied to the London Interbank Offered Rate (LIBOR), the Citco group of companies’ technology enhancements related to the LIBOR transition have now been tested and implemented.
These enhancements are operational in nature and have not altered the format of our current reporting, and we are now in the final stages of affirming operational readiness across our various lines of business.
We would like to remind you again that if you have not yet formulated a plan or approach to the transition, we would recommend taking immediate action to evaluate your exposure and next steps.
On July 29 2021, the Alternative Reference Rates Committee (ARRC) announced its formal recommendation of Term SOFR. This came days after the execution of the Commodity Futures Trading Commission (CFTC) Market Risk Advisory Committee’s recommendation to switch interdealer USD LIBOR linear swaps to SOFR linear swaps on July 26, 2021.
Since the announcement of Term SOFR, the volume of transition notices is surprisingly low coming to the end of Q3. The low volume of contracts transitioning from LIBOR to Alternative Risk-free Rates (ARR) is signalling that market participants intend to take advantage of the publication of USD LIBOR until June 2023.
Most agents and loan originators are pivoting to leverage Term SOFR instead of daily SOFR indices. The ARRC, Loan Syndications & Trading Association (LSTA) and other organizations are actively encouraging lenders to move swiftly to Term SOFR for new loan origination. This is in accordance with the Federal Reserve Board’s encouragement to cease entering into new contracts referencing USD LIBOR past December 31, 2021.
As noted in our July 2021 update, CME Group is the official administrator and source for Term SOFR. As of September 2021 CME has announced they are waiving the licensing fee for Term SOFR use in Cash Market Financial Products through 2026.
CONVERSION OF CLEARED CHF, JYP AND GBP IBOR SWAPS
The Central Clearing Counterparties, including CME, LCH and Eurex, have laid out plans to convert all in-scope cleared IBOR interest rate products to risk-free rate (RFR) Overnight Index Swaps (OIS) for CHF, JPY and GBP currencies.
Each IBOR swap will be terminated and replaced with a corresponding RFR OIS (replacement swap). The new replacement swap will have the same key economics as the legacy IBOR swap. On the date of conversion, a cash compensation amount will be applied as an upfront fee to the replacement swap. CHF and JPY swaps will be converted at close of business on December 3, 2021. GBP swaps will be converted at close of business on December 17, 2021. In advance of these conversion dates, basis swaps in these currencies were split into two vanilla fixed-float swaps on September 24, 2021.
In May 2021, the Alternative Reference Rates Committee (ARRC) announced CME Group would be the administrator for SOFR term rates once ARRC delivers its official recommendation for usage of these rates. The final step before an official recommendation takes place is the satisfaction of the following market indicators, as published by ARRC:
- Continued growth in overnight SOFR-linked derivatives volumes.
- Visible progress to deepen SOFR derivatives liquidity, consistent with ARRC best practices:
a. Offering electronic market-making and execution in SOFR swaps and swap spreads
b. Changing the market convention for quoting USD derivative contracts from LIBOR to SOFR
c. Making markets in SOFR-linked interest rate volatility products (including swaptions, caps, and floors)
- Visible growth in offerings of cash products, including loans, linked to averages of SOFR, either in advance or in arrears.
The Commodity Futures Trading Commission (CFTC) Market Risk Advisory Committee has annouced it’s recommendation for interdealer LIBOR linear swaps to be replaced by SOFR linear swaps. The replacement is recommended to take effect on July 26, 2021, and ARRC has welcomed the recommendation, stating its belief that the conversion will satisfy its published market indicators.
While the market continues to evaluate options, the discussions around TERM SOFR continue. It seems likely that there will be a recommendation, albeit limited, for the use of TERM SOFR. The hope is that the calculation convention will support an in advance calculation, in order to operate in the same manner as the current TERM LIBOR. We expect an update on this in the near term.
CDS CCP DISCOUNTING
Effective from June 14, 2021, Ice Clear Credit, Ice Clear Europe and LCH’s CDSClear transitioned from EONIA and Fed Fund LIBOR rates to ESTR and SOFR rates respectively for the calculation of Credit Default Swap (CDS) valuations, and interest on Mark-to-Market (MTM) calculations. The clearing of EUR and USD CDS contracts is highly concentrated amongst these Central Clearing Counterparties (CCPs). The switches followed a recommendation from the ISDA Credit Steering committee to make the changes at this time.
A one-time adjustment payment amount was posted to client accounts by the CCPs to reflect the one-day change in variation margin.
It is worth noting that CDS’ typically only have minor sensitivity to interest rates, so the impact on valuations will have been relatively small in most cases.
On March 5, the ICE Benchmark Administration Limited (IBA) shared the feedback received from its public consultation regarding IBA’s intention to cease publication of LIBOR benchmark rates. After reviewing the feedback, the IBA announced they would not continue publishing the following LIBOR rates after Friday, December 31, 2021:
- CHF LIBOR - all tenors (Spot Next, 1 Week, 1, 2, 3, 6 and 12 Months)
- EUR LIBOR - all tenors (Overnight, 1 Week, 1, 2, 3, 6 and 12 Months)
- GBP LIBOR - all tenors (Overnight, 1 Week, 1, 2, 3, 6 and 12 Months)
- JPY LIBOR - all tenors (Spot Next, 1 Week, 1, 2, 3, 6 and 12 Months)
- USD LIBOR - 1 Week and 2 Months
As proposed in their consultation. The IBA will continue to publish the following LIBOR settings until Friday, June 30, 2023:
- USD LIBOR - Overnight and 1, 3, 6 and 12 Months
This announcement comes as no surprise to those who have been following transition efforts within the market and has been met with applause from regulators and RFR working groups alike, as there is now a clear end-date to the publication of LIBOR benchmark rates.
Bloomberg spread fixing
Both ARRC and ISDA have confirmed that IBA’s announcement constitute an index cessation event under their fallback language. In accordance with Bloomberg’s IBOR Fallback Rate Adjustments Rule Book, the index cessation event has triggered the fixing of fallback spread adjustments as of March 5, 2021.
What you should expect moving forward
The IBA and FCA announcements have sent ripples throughout the industry, sparking a heightened sense of urgency around the transition. The big question in everyone’s mind now is – what is next? There seem to be some differing opinions on whether the announcement constituted an actual benchmark cessation event, with the ARRC and LSTA confirming that a cessation trigger event has occurred. The news does not fundamentally change or accelerate their plans in moving forward in transitions, however, it affirms that the end of LIBOR is in fact coming.
Most institutions, agents and lenders have already expended significant energy cataloguing their exposure, assessing their technology and evaluating operational implications of the transition; also, most parties have adopted ARRC or LSTA recommended hardwired fallback language that calls for a notification to be sent that a Benchmark Transition Event has occurred. Agents and Lenders are not required to immediately proceed to use of SOFR or applicable alternate reference rates, but they should follow best practice and confirm that an event has occurred pursuant to that language and put borrowing entities on notices that the LIBOR tenors in their documentation may cease to be available as of the IBA/FCA announcements.
These notices also reference the adjustment spreads issued by Bloomberg. Where the recommended fallback language is not in place, but the responsible Agent or Lender deems the language present acceptable, a notice of a trigger event may not be required. Where fallback language does not provide for a clear path forward, borrowers and participants should expect a notification from the Agent or Lender requesting their consent or approval to include the alternate language, assuming they have not already received it. It is expected that we could start to see Agent’s and Lenders taking next steps and actually transitioning by the beginning of the third quarter.
Within the derivatives space, we are also beginning to see brokers provide guidelines to clients for the Libor transition and options that may be available to them. We expect that all brokers will be in touch with clients to discuss the process and timing of the transition in the coming weeks, if they have not already. To avoid the end of year 2021 rush and the cessation of Libor for a number of currencies, we have seen some brokers provide the option to transition to the replacement RFRs or other alternative rates early. Please follow up with counterparties if you do not hear from them in the near future to discuss options that may streamline the transition. You may also want to follow up with counterparties to discuss the cessation of Libor in the event that they have not elected to adhere to the Protocol.
While industry activity around loans is starting to become more visible with most Agents starting to acknowledge that a cessation trigger event has occurred, the derivative market, with the advent of SONIA in 2020 has already started to take steps away from LIBOR. In particular, we see this shift in our current portfolio.
The most prudent action to pursue at this time is an update of your updated contact details in the Admin Details Form (“ADF”) if you believe your information is stale or if you have unofficially reallocated exposures between funds under your management. As an Agent or Lender, you would be expected to have concluded or be concluding your efforts around update of fallback language and technology revisions. Those further down the path are likely to be having detailed conversations about operationalizing the transition. If you have not yet formulated a plan or approach to the transition, we would recommend taking immediate action to evaluate your exposure and next steps. Citco is happy to support our Clients to navigate the next phase of this transition journey.
January 25, 2021 marked two critical transition milestones according to the Alternative Reference Rates Committee (ARRC):
The International Swaps and Derivatives Association (ISDA) IBOR (interbank offered rates) Fallbacks Protocol and IBOR Fallbacks Supplement took effect.
- The Protocol going into effect means that existing derivatives contracts will now incorporate ISDA’s new fallbacks if both counterparties have adhered to the Protocol or otherwise bilaterally agreed to include the new fallbacks in their contracts.
- The Supplement going into effect means that new derivatives contracts that incorporate the 2006 ISDA Definitions and reference a relevant IBOR will also incorporate the new fallbacks.
The ICE Benchmark Administration (IBA) closed a consultation that it had released in December regarding its intention to cease the publication of LIBOR settings.
- With respect to U.S. dollar (USD) LIBOR, that consultation included proposed end dates immediately following the December 31, 2021 publication for the minor LIBOR settings (1 Week and 2 Month) and immediately following the June 30, 2023 publication for major USD LIBOR settings (Overnight, and 1, 3, 6, and 12 Month).
- As IBA has noted, “After the feedback period has closed, IBA intends to share the results of the consultation with the FCA [Financial Conduct Authority] and to publish a feedback statement summarizing responses from the consultation shortly thereafter.”
As of Nov 30, 2020, ICE Benchmark Administration Limited (IBA), the administrator of LIBOR, announced a consultation on the extension of the LIBOR transition deadline to the end of June 2023.
While the Federal Reserve Board, Alternative Reference Rates Committee and International Swaps and Derivatives Association have supported the extension announcement, they have also been careful to highlight that the initiative is not intended to create a full extension of the LIBOR demise process. Instead, it is intended to ease resolution and mitigate risk around “tough legacy” products and transitions, and serves to increase the likelihood of natural attenuation. All bodies have been clear that financial and servicing institutions have been encouraged to stay the course around language remediation and adoption - as the deadline to cease origination of new products tied to LIBOR has not been altered at this point in time.
At this critical juncture for financial markets, Citco’s team of seasoned loan professionals is here to help our clients through the transition.
The introduction of Risk-Free Reference Rates raises a number of complexities, such as how to incorporate robust fallback language into existing floating rate notes, loans, securitizations derivatives, and cash products; this is in addition to the introduction and maintenance of transactions and instruments that utilize alternative reference rates in place of LIBOR.
Whether you are seeking core services such as payment and transaction processing – or enhanced agency solutions for syndicated and complex transactions – Citco is available to help you navigate this shift in the operational landscape.
At Citco, we understand how changes in day-to-day loan activity impact your portfolio and are actively supporting our clients who invest in leveraged loans, private credit and commercial mortgages to prepare properly. We are conducting a ‘systems-readiness’ check with a forward-looking approach and compiling clear guidance from the ARRC and its international peers to properly prepare our global clients for the transition. Furthermore, we continue to help managers ensure issues that require special attention are well tracked, such as credit agreements without sufficient fallback language that can trigger cash management or paydowns issues if breached.
Our deep-seated knowledge of loan servicing combined with alternative investment fund administration has allowed us to prepare for whatever challenges may present themselves in global credit markets. Elaine Furnari, Head of Loan Services at Citco Fund Services (USA) Inc., who also sits on a number of ARRC’s operational committees, is leading our support on Risk-Free Reference Rate preparedness.
- Bank of England Fact Sheet
- Alternative Reference Rates Committee (ARRC) (US)
- ARRC paced transition plan
- Loan Syndications & Trading Association (LSTA) (US)
- Mortgage Bankers Association (MBA) (US)
- International Swaps and Derivatives Association (ISDA)
- The Bankers Association for Finance and Trade (BAFT)
- Bank of England (UK)
- Financial Conduct Authority (UK)
- Loan Market Association (LMA) (EMEA)
- IFRS (International Financial Reporting Standards) – IBOR Reform and its Effect on Financial Reporting (Phase 1)
- IFRS (International Financial Reporting Standards) – IBOR Reform and its Effect on Financial Reporting (Phase 2)